What’s the Difference between Mortgage Rate and APR?

Whenever mortgage lenders show an interest rate in their advertising or their written rate quotes, they’re required to prominently display a second number – the Annual Percentage Rate, or APR. That rate is usually (but not always) higher than the interest rate (which might also be called the stated rate or advertised rate). SeeIs APR Always Higher than the Interest Rate?

What Is APR? Is it Something You Need to Pay Attention To?

APR disclosure is required by law because it’s designed to make shopping for a mortgage easier. By itself, the mortgage rate doesn’t really tell you much. If one lender quotes a five percent rate for a $100,000 loan and another lender quotes a 5.5 percent rate, it looks as though the first loan is the better deal. But what if you learned that the first loan costs $20,000, while the second loan only costs $1,000? Wouldn’t that make a difference?

Of course it would – and that’s why lenders have to disclose those costs. They don’t list the charges for the loan in their advertising, however – they use the APR to show that there are costs. The APR re-states the interest rate but incorporates the costs of the loan. If you see that the first loan in our example has an APR of 6.68 percent, while the second loan’s APR is just 5.59 percent, you know that the second loan is probably (but not always!) the better deal.

APR can also help you understand the effect of paying discount points to “buy down” your interest rate. For example, with the $100,000 loan in our example, does it make sense to pay an extra $3,000 to lower the rate from 5.5 percent to 5.125 percent? Let’s see – the APR of the more expensive loan is 5.48 percent while the cheaper loan’s APR is 5.59 percent. In this case, it might make sense to spend the money upfront to get a lower rate for the life of the loan.

What Costs Are Included in the APR?

The law doesn’t specify what exact charges make up the APR, but it should at least include fees that go to the lender, such as origination, processing, documentation and underwriting charges. APR also includes mortgage insurance. That way you can compare loans with different mortgage insurance requirements and choose the program with the lowest overall costs.

Finally, APR incorporates the potential interest rate changes of adjustable rate mortgages (ARMs) and hybrid ARMs -- within certain limits. SeeAPR and Adjustable Rate Mortgages to understand how ARM annual percentage rates are calculated. It’s really important to know if you shop for a hybrid ARM or adjustable rate mortgage!

Understanding APR can help you choose the best mortgage program and pricing structure for your situation, and it can also help you find the cheapest loan provider. See Using APR to Shop for a Mortgage to learn how to get your best mortgage rate by comparing APR disclosures.

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